Using Passive Income Systems To Make Money

I mentioned in my last post on passive income that there is a better way to make money than by trading your time for cash. The problem with how most people make money is that they only get paid when they are working. I don’t know about you, but that seems like a rather glaring problem to me. I’d like to get paid 24 hours a day, thank you very much, instead of just during my work hours. Let’s have a quick refresher look at the difference between earned and passive income and then talk about passive income systems.

Earned vs. Passive Income

Most people make money by trading their time for a salary. You work 40 hours a week, and your employer gives you a paycheck a couple of times each month. It’s a pretty simple deal. You come in and work, and you get paid. Stop coming into work, and you stop getting paid. This is called earned income. The amount you get paid is directly related to the amount that you work. (There are always some exceptions to this rule. For instance, vacation and paid leave allow you to not work and still get paid, but the rule still stands. If you stop going into work, you will stop getting paid.)

Passive income (or its cousin, residual income) is different from earned income in that it doesn’t require you to trade your time directly for money. Passive income is generated by systems that earn money constantly, regardless of whether you are working on that system or not.

When most people first hear about passive income, a lot of these terms don’t really make sense. “What exactly do you mean by a “system”? “How does it earn me money when I’m not working on it?” Let’s take a deeper look at some passive income systems and exactly how they generate income.

Passive Income Systems

A passive income system is simply any business, job, or property (physical, intellectual or otherwise) that continues to produce income for you even when you are not working on it. Here are some examples.

Investments – Probably the most “pure” example of passive income is having a large amount of money invested in the stock market, and living off of the interest generated by your investments. This leaves the principal free to be reinvested, generate more income, and the cycle repeats itself. Unfortunately, this option needs large sums of money to make it work, so unless you are already independently wealthy this is not really an option.

Owning a Business – Owning a business can be a great source of passive income. Hire a manager to take care of the day-to-day operations, and your business will generate income even when you’re not there to run it. You can even start a franchise – such as a fast food restaurant, shipping store or janitorial service – and you won’t have to come up with the basic idea or business plan by yourself.

Rental Properties – Have you ever rented a house or apartment? Did you notice how your rent was due every month, regardless of how often you saw the landlord? That sounds suspiciously like passive income. If you own the property, your tenants pay their rent on a regular basis, whether you are there working on the house or not.

Running a Website – Running/owning a website or blog is another great source of passive income. Once you have a decent amount of traffic coming in, there are several methods of monetizing the site: putting up advertisements, charging for content, selling a product, etc. The point being, readers/users are still coming to the site even when you’re asleep, thereby helping you make money.

The common factor in all of these systems is that your time is not tied together with the amount you get paid. This is unfortunate at the beginning because you’ll be working long hours for very little pay. But after while, if you keep at it, your income will start to increase. At some point your income will be roughly approximate to what you would expect to get paid in a similar salaried position. At that time you can decide whether to invest more of your time into your business to increase your salary even higher, or whether you want to lower your hours to spend time on other projects.

Maintenance

There’s one other thing to mention on this topic and that is the maintenance you’ll need to do on these systems. No matter what sort of system you set up or how well it’s done, you’ll always have to spend some amount of time maintaining the system to keep it going. If you have several million dollars in the stock market, you (or your financial advisor) will have to keep an eye on how your investments are doing to make sure you’re still making money. If you own rental houses and you never maintain them, before too long the roofs are going to be full of holes, the gardens will be full of weeds and you won’t be able to find anyone to rent them from you.

Don’t confuse maintenance with being tied to the clock like a real job. You still get to choose when to work on your business(es), you get to choose whether to do the work yourself or pay someone else to do it, you get to decide what needs to be done about problems that arise, etc. You’re still in charge.

So what other passive income systems are there? I always love hearing about how other people are using some creativity to make money. Let me know in the comments if I’ve missed any.

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This is Part Two in my series on passive income. Check out the other parts below.

1) All Income Is Not Equal
2) Using Passive Income Systems To Make Money

Make Money as an Employee

The default way to make money in America is to get a job. I don’t know if you realize it, but pretty much everyone assumes that you are or will be an employee. This assumption is such a part of the fabric of American consciousness that most people never even question it. When you graduate from college everyone asks you, “Have you gotten a job yet?” When you meet someone new the first question is “So, where do you work?” These questions seem normal.

While making money as an employee is a good option for many people, most of us (including myself) never made a conscious decision to make money from employment. We just fell into it by default. And that’s the problem. If you’ve never evaluated the benefits and risks of being an employee and compared them to the risks and benefits of other ways to make money, then you may have set yourself up for some avoidable displeasure.

In this post, we’ll begin to step back and take a fair look at employment. First we’ll discuss the basics of the system and then we’ll look at some pros and cons of employment. We’re also going to introduce some criteria that we’ll use to evaluate any income system, whether it’s being an employee, making money online, or investing your money. The criteria we use to evaluate income systems are as follows: The Asset – what exactly it is that is making money in this system; The Cash Inflows – specifically how income is received from this system; The Taxes – how the system and the income it generates are taxed; The Cash Outflows – the expenses and debts created by the system; and lastly, System Control – who exactly controls and runs the system.

Looking at these criteria allow us to systematically examine any method of making money and determine what the pros and cons of that system are. Let’s now take a look at employment as a system for making money.

The Asset:

All systems of making money fall into one of two categories:

1)trading the use of an asset for money, or
2)creating or adding value to an asset that you then sell.

Employment falls into the former category since you are the asset that is being traded for money.

Think about that for a minute. Does that seem a bit Orwellian to you? “You are the asset that is being traded for money.” If you strip away all of the emotional and human aspects of your job and just look at it from a financial standpoint, that’s exactly what is happening. Or, if we want to be more specific, your time is the asset being traded for money. You go to work, give eight hours of your life to your boss, and he or she pays you a salary. If you stop giving him your time, he stops giving you his money.

The Cash Inflows:

Typically an employee agrees to perform specified tasks or meet certain goals in exchange for cash pay and non-cash benefits. Wages are generally received on a weekly, biweekly or semi-monthly schedule. Benefits may include paid vacation, paid sick-days, subsidized health and life insurance, and training.

The Taxes:

Wages from employment are generally subject to federal, state, and local income taxes as well as payroll taxes (FICA and Medicare). These taxes are withheld from each paycheck so there is minimal opportunity for tax planning or tax deferral. This is important to note since taxes on wages are generally higher than on other forms of income.

For example, if I were making $400,000 a year (I’m not yet) then I would pay tax at the following rates:

Federal: 35% of taxable income
State: 5% of taxable income
County: 1% of gross wages
City: 0.5% of gross wages
Payroll: 7.65 of gross wages

That’s a total of 49.15%. So for every additional dollar earned I only get to keep 51 cents. However, if that additional dollar of income came from a rental property then I could keep 60 cents. And if the additional dollar came from a capital investment in a business then I could keep 80 cents.

Cash Outflows

Working as an employee also causes you to incur expenses. You will probably have automobile expenses due to a commute, and could possibly even need to purchase an additional vehicle. On top of that, additional costs for clothing, medical treatments, food, and insurance should be expected.

System Control

When you work as an employee, the system that is generating your money (the business that you work for) is going to be owned and controlled by one of several people – it might be your boss, it might be a group of partners (such as a law firm) or, in a large company, it might be the shareholders. The important thing to note here is that in all of these situations, the system is not controlled by you. You will generally have little to no say in the operation of the business, the clients it takes, or how much money it makes.

This is part one of our look at employment as a system to make money. Hopefully this has helped you think about having a typical job in a new light. In our next post, we’ll examine employment further and see when it’s a good idea to have a job and when it’s not such a good idea.

Changing Your Beliefs To Make Money

I’m a big videogamer. Have been for years. I got hooked on the old Super Nintendo system in the early 90s, moved to PC games in high school, got an XBox after college, and just recently got an XBox 360. After finally being able to finish the Halo series, I started playing Fable 2. RPGs are generally my favorite genre of game, and I was a big fan of the original Fable as well.

One of the neat things about Fable is the ability to play either a good or an evil character. Good characters perform civic duties, protect citizens against bandits, support their families, and generally don’t break the law. Evil characters rob people, kill indiscriminately, take what they want from shops and stores, and wreak havoc on society in general.

As fun as all of that is, there is one thing illustrated very well in Fable that is a valuable insight to helping you make money. Several times in the game, you are forced to choose between morality and money. For instance, you may be hired by the city guards to go rescue some villagers that have been kidnapped by bandits. When you get to the bandit camp to free them, you find that the bandits will offer you more money than the guards are paying you to let them keep the villagers as slaves. So you’re faced with the dilemma of whether to do the “right” thing and and free the villagers, or take the money and let the bandits do as they wish.

There are several other examples of this in the game. If a shopkeeper has a fancy new sword that you want, but you don’t want to pay the full amount for it, you can threaten him to get a better price. If he doesn’t drop it low enough, you can even kill him and get a much better rate from the new shopkeeper that takes his place (who is inexplicably rather terrified of you). In another instance, you can buy properties in the game and rent them out to tenants. Raising the rent means more money, but it counts as an evil act as you are unduly burdening the townspeople.

So what does this have to do with learning to make money?

Here is the single most important thing you can ever learn about creating wealth: Your beliefs about money determine whether you will ever become wealthy or just be average. In fact, it’s bigger than that. Your beliefs about money determine your entire financial reality.

What does that mean exactly? Whether you realize it or not, your beliefs determine the large majority of your thoughts and actions. Have you ever put your keys down on a desk and worried that they would float away? Of course not. Your belief in gravity is unshakable. Do you believe that the only way to make money is to have a job and work for someone else? Then you will never investigate or seek out other opportunities for creating income.

Here’s where this ties into the examples from the videogame. If you believe that you are generally a good person (and nearly everyone does), and yet, deep down, you believe that money is evil, you will never create any sort of real, lasting wealth in your life. If you believe this sort of thing, then whether overtly or subconsciously, you will repel wealth and the things you need to create it – the people, the things, the knowledge – from your life, instead of attracting them to you. Why would a good person need or want something evil?

Let’s look at some negative beliefs you can have about money. Maybe you don’t quite believe that money itself is evil, but you might believe that, in order to make money, you will have to engage in activities that are morally shady or that violate your values. Do you believe that you’ll have to sell out or change who you are to make money? If you meet a wealthy person, do you assume that they will be stuck-up or arrogant? Do you assume that the wealthy acquired their money by exploitation and dishonest means? Do you identify with Robin Hood, who stole from the rich and gave to the poor, or do you see him as a thief who took what was not his and gave it to those who had not earned it?

The more you consider your beliefs about wealth, the more you will probably realize that you do have negative beliefs about it. That’s OK for now. Don’t try and change everything at once, just try and identify the beliefs as you come across them.